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Welcome to the derivative world of the 'sub-bit swaps'

A surge in interest in Indonesian sub-bituminous coal swaps beginning in April has convinced some major coal players that the swaps could become the world's biggest coal derivatives market.

"Indonesian sub-bit is fast emerging as an important supply source in the Pacific," Zenny Tran, coal team leader at Singapore-based brokers Ginga, told Reuters'Jackie Cowhig. "The physical seaborne traded Indo sub-bit market is probably more than 100 million tonnes a year, which is more than exports out of South Africa's Richards Bay, and lots of this is traded on the spot market to India, China, Korea, Taiwan and South East Asia. This makes a great fundamental for a derivatives market to develop from," she added.

According to Cowhig, standard coal prices of around $120 a tonne are nowhere near 2008's record of over $180 a tonne FOB Newcastle, but they are high enough to have caused a big shift in buying patterns this year.

The rise in physical sub-bituminous prices from $82 to $89 a tonne after China scooped up a string of cargoes in April helped draw in new players, said an official at brokerage Spectron, which has recently started to broker sub-bit swaps. Around 280,000 tonnes of sub-bit swaps traded in May, up from almost nothing in 2010 and roughly a trade a week in the first quarter. The current activity still is far less than the daily trade in API2, API4 or Newcastle swaps, but the rapid growth suggests this will escalate, the brokerage official said.

Utilities, traders and banks who are long-established players in the liquid API2, API4 and Newcastle swaps markets, said they have been drawn to sub-bit swaps by the rise in physical prices this year as well as by a desire to get in early on a nascent market, which seems to have the scope for rapid growth.

"Sub-bit swaps have the potential to be huge, bigger than the APIs because of the sheer volume of underlying physical trade. It will be the largest coal market in the world," said an Asia-based trader with a major European utility.